11

The Strange Debt-Ceiling History Behind the Fiscal Cliff

There wouldn't be a fiscal cliff without the debt ceiling. So why does the United States have a debt ceiling? And how did it pass into law? To understand how we got here, it helps to know where we've come from. The origins of the debt ceiling are buried in several crisis-driven legislative acts, each contributing a part of the puzzle that has given Congress a political football and the country its fiscal cliff. Let's examine the history of these acts to figure out how they've shaped the debate to this day.

An unusual situation Most countries have no such limits to their debt. The only legislative arrangement that comes close is Denmark's, but that country operates under a multiparty system in which no single party has held a majority since the turn of the 20th century, and in which coalitions of several parties are the norm. Denmark's debt ceiling also happens to be far higher than that country's current debt level, and its last raise more than doubled the height of that ceiling. The American debt ceiling, in contrast, has been nudged higher bit by bit over the years, usually to a point that requires raising it again within a year or two.

How we built this ceiling How did the U.S. get to a point where government debt could be used as a political hostage? It all began 95 years ago. America had been goaded into war by Germany's aggressive acts, which included a catastrophic diplomatic effort to turn Mexico against the U.S., as well as submarine attacks on American ships. The country needed to raise a lot of money -- and fast -- to mobilize. The only problem was that each individual issue of federal debt had to first be approved by the government. With a war to manage, Congress had its hands full.

The legislature came up with a solution to lighten its workload in the Second Liberty Bond Act of 1917. This act not only authorized the issue of at least $3 billion in new Liberty bonds, but also set a limit to the total debt capacity that the U.S. could issue -- although this limitation was distributed in piecemeal fashion across both the newest Liberty bond issuance and older federal debts. The Treasury, in charge of debt issuance, was granted more power and flexibility to manage the nation's finances. The first "debt ceiling" had been created, and the U.S. was free to issue $11.5 billion in new debt, equal to about $193 billion in today's terms.

The Second Liberty Bond Act remained the core piece of debt-raising legislation until 1982, as Congress continued to amend the Act each time an increase or policy change became necessary. However, it took the looming threat of another World War to consolidate the separate debt limits into one overarching debt ceiling. On July 20, 1939, the Public Debt Act came into force. Its particulars, according to a review of 1939's Congressional measures by The New York Times, were:

Amends Section 21 of the Second Liberty Bond Act by striking out the limitation of $30 billion on the amount of bonds which may be outstanding at any one time. ... The purpose of this act is to provide greater flexibility in management of the public debt. Under the Second Liberty Bond Act, as amended, the total amount of public debt obligations which may be outstanding at any one time is $45 billion, but this was subject to a limitation (now repealed) of $30 billion on the amount of bonds which might be outstanding at one time.

This Act represented the near-completion of the present-day debt ceiling. It aggregated the debt of the United States and granted the Treasury ever-greater control in managing the size of that debt up to pre-determined limits set by Congress. But it took two more acts of Congress, one in 1941 and one in 1974, to establish the modern legislative process (and all of its pitfalls) with which we're now familiar.

The debt ceiling's construction completedRemember Denmark's example? Until 1941, our debt ceilings looked somewhat similar. The limit of allowable debt to GDP was much higher than the actual debt-to-GDP ratio of the U.S. through much of the Great Depression, which is the earliest period for which that data is available. By 1941, high levels of stimulus spending had pushed total government debt near its limits. The New York Times had the inside scoop on the Feb. 10 passage of the Public Debt Act of 1941, enacted to push the ceiling higher and consolidate federal borrowing power in the Treasury into its present form:

The House voted today to increase the maximum limit on the national debt from $49 billion to $65 billion and declined, because of the urgencies of the world situation, to give any promise that the "ceiling" would not be moved even higher.

Faced with the Administration's statement that the government's credit would be exhausted by May if the bill were not passed, members of the House defeated a Republican amendment to limit the debt to $60 billion and passed the bill with a minimum of political bickering.

Then, as now, the imminent breaching of a debt ceiling gave the political minority fuel for dissent. The Times report continues:

[The Republican] spokesman said that the national debt of this country was less than $21 billion on March 4, 1933, when President Roosevelt's first term began. They spoke of the Administration's "extravagant and wasteful spending orgy of the past eight years," condemned the President's "pump-priming and boondoggling schemes," and asserted that most of the present debt of more than $45 billion had nothing to do with national defense.

The Public Debt Act of 1941 set in motion a recurring theater of political wrangling over a debt ceiling constantly at risk of being breached. Ever since the passage of this Act, the debt limit as a percentage of GDP has always closely tracked the actual total debt-to-GDP ratio in the U.S.

Until 1974, however, the debt ceiling was part and parcel of the federal budget bill. This changed with the Congressional Budget and Impoundment Control Act of 1974, passed in response to President Nixon's efforts to cut the deficit by refusing to disburse $12 billion in appropriated federal funds. The Act, which passed over Nixon's veto shortly before his resignation, centralized and strengthened Congressional budgetary authority in several ways. One of these fortifications included separating the debt-limit debate from the annual budget process, intended to encourage further debate on the debt ceiling. Ever since, the debates have raged with varying intensity, with some so heated that they have shut down, or very nearly shut down, the federal government.

It's a long way down Today, the debt ceiling has become a weapon in the hands of a minority party. It's doubtful that the drafters of the Second Liberty Bond Act or the Public Debt Acts would have expected such an outcome. It's doubtful that we even need a debt ceiling at all. Still, understanding the history of this complicated process can offer a greater insight into the usefulness of its current form. What should be done with the debt ceiling? Have any of these historical precedents got the right of it, or is the debt ceiling simply a relic of a different time, ready to be discarded? Whatever your opinion, please feel free to share it in the comments below.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

this is all very interesting on the debt ceiling. It is unclear why we need not continue the debt ceiling. You jump to that conclusion without declaring your reasoning.

What is baffling is to leave the debt ceiling as the fiscal cliff. The cliff is more associated with incredible jump in taxes and cuts of indescriminate nature to defense. Defense gets 50% of the curts when it is less than 10%-15% of the overall budget.

When you create tax cuts that expire on a arbitrary date you plan on a big jump in taxes. In addition that date has a 50-50 chance of being at a bad time.

When you do not rationally set out budget cuts you end up with extreme cliff in cuts. That was done last year in 2011 when congress could not agree and get the job done.

@DocPhoton You said "Today, the debt ceiling has become the only brake that can be applied to runaway spending pumped up by an out of control cabal of media, the Senate, and the White House."

How many times has the debt ceiling stopped federal spending?

Zero. It's never stopped a dime. It's pure political theater.

Commenting on the fact that politics exist is not political commentary. It is a statement of fact. And the debt ceiling being used as a political weapon is not a "viewpoint." It is simply the truth. When a political party - and it doesn't matter which one - uses the debt ceiling as a hostage and threaten harm to the United States and its citizens, then that is a weapon by any definition of the word.

You are free to disagree, but the sky will still be blue and the grass will still be green regardless of your position on those topics, as well.

And I'm sorry for coming on so strong with that comment, but it frustrates me to no end how any attempt to describe our actual political situation is met with cries of "partisanship" and a lack of "neutrality" in an attempt to stifle debate.

It is unconscionable to me that people are offended by mere words but not offended by the concept of threatening the future of this nation in an attempt to extract concessions.

Sending report...

Alex Planes specializes in the deep analysis of tech, energy, and retail companies, with a particular focus on the ways new or proposed technologies can (and will) shape the future. He is also a dedicated student of financial and business history, often drawing on major events from the past to help readers better understand what's happening today and what might happen tomorrow.